The news that activist investor Elliott has taken a greater than 10 percent stake in Southwest Airlines has been the talk of the town this week. The more discussions I’ve had with people about this — and there have been so many — the more I’m convinced that the cynical take on this whole thing is the right one. Elliott is not here to actually fix Southwest.
Elliott has one goal, and that’s to make a good return for its investors. That is the whole reason that Elliott exists, really. As much as people love to hate Wall St and the finance world, there’s nothing wrong with this at all. The point of the enterprise it to look for opportunties to make money quickly, and it saw Southwest just sitting there, waiting to be taken advantage of.
Slide 18 of Elliott’s presentation shows the real motivation here:
It’s the note in red that matters. The value of Southwest’s aircraft alone exceeds Southwest’s market cap. That means there is value to be extracted.
The other key piece is on slide 11:
Southwest has a lot of cash and not a lot of debt. This means Elliott really can’t lose. If it can get some quick hits through strategy and the stock spikes, it wins. If it can get Southwest to juice the share price by doing big stock buybacks using its cash or by levering up, Elliott wins. Or, if it has to break the thing up and sell it for parts, it wins. There is no losing for Elliott… just for Southwest.
For this reason, Elliott feels emboldened to swing for the fences. I might say Elliott is Southwest’s Rick Dubinsky. You all remember the famous quote from those contentious labor negotiations at United 25 years ago, right?
We don’t want to kill the golden goose. We just want to choke it by the neck until it gives us every last egg.
Elliott doesn’t seem to understand the US airline industry, or at the very least it doesn’t understand Southwest. But it also knows it can’t just go in and rape and pillage, because there will be too much pushback from long-term investors. It’s smart enough to know that investors aren’t pleased with the state of Southwest’s share price. It also knows that labor has called for change at the airline — though that’s usually just during labor negotiations and the rhetoric has quieted down.
With that knowledge, Elliott is trying to find the easiest way to turn Southwest into an ATM. It only has a little over 10 percent of the airline’s shares, so it needs investor allies. And that’s where it focused its attention first.
I don’t know if this has changed, but in the first day or two, I’m told Elliott didn’t even try to talk to labor. It’s entirely possible that labor just wasn’t as important in Elliott’s minds and they’ve gotten there now, but it’s a critical mistake if you’re trying to win hearts and minds.
A look through the deck shows that there is no real plan here. The company threw together more than 50 pages, and it dedicated very few to actually suggesting what fixing can be done. But of course, it has to have an idea of what it would fix, so it can create models that show the potential opportunity. I will try to dive into this in a future post, but honestly, there’s not much to dive into. This just looks like a company that has no understanding of what makes Southwest tick.
Elliott knows that it just needs to get control, so it wants to kick out the board chair and install more independent (read: independent from the airline but connected to Elliott) directors. It then also wants the CEO out. If it succeeds, it can find someone who will push through strategy changes that will make money quickly regardless of long-term impact. That will help push the stock up. If that doesn’t work, it’ll have its own people running the show. They can increase dividends, buy back more stock, or do whatever is necessary to allow Elliott to get out of there quickly with a bunch of money.
Once Elliott is gone, however, then what? Southwest may find itself trying to pick up the pieces if it doesn’t navigate this well. On the other hand, it could be turbocharged if it gets focused, speeds up change, and rallies the entire team to prevent a shift in management. The airline needs to fight, and fight hard while also talking to Elliott behind the scenes to limit the damage.
Early indications unfortunately suggest Southwest isn’t going in that direction. In a sleep-inducing statement, the airline said it would be happy to meet with Elliott and that it “maintains an open dialogue” with shareholders, and… oh I stopped reading. Does anyone think this is how Herb would have reacted? This is not the fabled Warrior Spirit. Bob isn’t Herb, of course. But it’s time to start mobilizing the troops.
Herb Kelleher Arm Wrestling Image via Southwest Airlines
In the end, Elliott is very likely going to come out of this just fine regardless of how this ends. But how Southwest handles this will determine what the airline looks like when Elliott is gone. The pressure is on to preserve what Elliott apparently seems content to destroy.
